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The Added Security of Covered Bonds

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Why Covered Bonds Are Better

Covered Bonds

Ever since the economic crisis started in 2008, covered bonds have had a bad reputation. They are accused of providing investors with a false sense of security and have even been partially blamed for the economic crisis itself. Nevertheless, this type of bond continues to offer investors a number of benefits over standard bonds. First, consider how a regular bond functions. When an investor buys a bond, they are essentially loaning money to a governmental body or a corporate entity. The loan agreement has set terms that define the amount of interest, the number of interest payments and the date that the bond will reach maturity. The borrower, or issuer of the bond, pays interest at specified times. Once the bond reaches maturity, the principle is repaid as well.

Even regular bonds are considered to be relatively secure. As long as the company does not become insolvent, the interest payments and principle will be paid as specified in the bond agreement. There are, however, a surprising number of companies facing bankruptcy. In trying economic times, even a bond can be risky. When you buy a covered bond, however, you protect yourself from the risk that the company will go under. Covered bonds are backed by money from other sources such as mortgages or public sector loans. Because both the debt and the asset pool are kept on the issuers financials, the issuer can be held responsible if the bond goes bad. The investor has recourse to the issuer as well as the cash pool.

Are Covered Bonds Safe?

Covered bonds carry some risk, as do all investments. The biggest flaw in the covered bond system is that the mortgages and loans used to back the bonds can go bad. Financial institutions have learned a lot, however, since the mortgage crisis started. New, stringent guidelines are ensuring that mortgages and loans are only granted to those who can make payment. This means that covered bonds are safer than ever before.

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